Hi everyone, so from my previous video we've understood what the functions of the price mechanism are and how they work. In this video we want to apply those same functions to when demand and supply curves shift. Let's start by looking at a demand curve shifting to the right. Now we know what all the factors are that can do this, we've learned them as specific factors, but when we covered those factors we said they're all non-price factors that shift the demand curve, meaning when this demand curve is shifting to the right, It's shifting at the initial price in the market, which in this case is P1.
So our job always, when a curve is shifting, is to find the disequilibrium, which will always exist when a curve is shifted. So in this case, demand has shifted right, but it shifted at the initial price of P1. So extend P1 across to find the new demand, which is all the way over here, call it QD, where supply has remained at Q1.
So demand is greater than supply. This is an excess demand. This is a shortage. That's the disequilibrium. Once you've found that, it should be easy to understand how the functions of the market will take this away, will correct this problem, because we covered that in my previous video.
But let's do it again. So in reality, firms are going to be seeing large queues of people desperate to buy this good or service. There'll be long waiting lists of people desperate to buy this good or service. There could be competition between buyers, right? So it's clear firms are not able to supply the demand that's out there.
but also firms are seeing customers, consumers who are bidding up their prices. They are so desperate to buy this good or service. So naturally what happens with prices?
Prices rise. We learned in my previous video that excess demand puts upward pressure on prices. So on our diagram, let's say the price rise is perfect from P1 to P2.
In reality, this will be numerous price rises before we get to P2, but let's keep things simple and just go straight to P2 here. At which point... BAM! The functions of the price mechanism kick in. We know that now at higher prices.
Just think ARSI. ARSI. Yes, those functions kick into gear. Yes, what happens first?
Well, higher prices signal the fact that there has been excess demand for both consumers and producers, but also higher prices signal the need now for more, more resources in this market. Higher prices incentivize firms to increase their output. to make more profit of course now produce more you can sell more at a higher price what a way to make more profit we can show that function via an expansion along the supply curve or an extension along the supply curve so this could be new firms entering the market this could be existing firms increasing output by investing in new capacity or using up spare capacity but there we go that is the incentive function higher prices also ration scarce resources, in this case by discouraging consumption. We can show that via a contraction along the demand curve. Put those last two effects together, where do we end up?
We end up with quantity Q2, which is at equilibrium, which we know is allocative efficiency. Awesome, awesome, right? So we've achieved allocative efficiency, we've achieved equilibrium. The reallocation of resources is now with a higher quantity at higher prices.
That's... how markets work when we have an increase in demand demand shifting right how do we get from p1 q1 to a new equilibrium all sorted thanks to rc let's do the same thing for a supply shift to the right once more we know what all these factors are we've learned them as pints wc factors and again these are all non-price factors so like before when the supply curve shifts it will shift at the initial price in the market in this case p1 we need to find the disequilibrium once we find that we can rocket forward from there. So with this supply shift to the right, that's happened at P1, extend that price line across to get the supply, which is now over here at QS.
The demand has remained at Q1. Supply is greater than demand. This is an excess supply. This is a surplus.
At this point, again, we should know how this is gonna be self-corrected, but let's go through it to make sure there's foolproof understanding. So what are firms gonna be seeing with an excess supply, with a surplus? Their warehouses are going to be full of stock. Physical stores are going to be full of stock on the shelves.
If you're a restaurant, your tables are empty. Your kitchen is full of ingredients, right? At which point, prices naturally fall.
Yes, covered that in the last video, didn't we? And we know that excess supply surpluses put downward pressure on prices. Again, let's say it's a perfect price fall from P1 to P2.
In reality, it will be numerous price drops before we get to P2, but let's keep things simple here. At which point, bam! Arsey, the functions of the price mechanism kick in. Yes, they do.
And that's how we can end up at this new equilibrium. What happens first? Well, lower prices first signal, signal that there has been an excess supply to both consumers and producers, but they also signal the need for fewer resources, less resources in this market.
Lower prices incentivize producers to reduce output. Instead, liquidate stocks, sell your stocks. That's the way to increase profit by cutting output and liquidating stocks. We can show that effect via a contraction.
along the supply curve. So what's happening here? This could be firms leaving the market or existing firms cutting capacity, reducing output that way. That's the incentive function. At the same time, lower prices ration scarce resources.
In this case, by encouraging more demand, the expansion or the extension along the demand curve shows that effect. Put those last two effects together, where have we ended up? We've ended up at a new quantity, Q2. Wonderful.
This is an equilibrium. We know equilibrium is allocative efficiency. It's like magic, right?
These functions of the price mechanism are magical things. Absolutely. Lo and behold, equilibrium, allocative efficiency, excess supply completely taken away.
Incredible to see this in reality like this. We've done it. The functions of the price mechanism, how they work in getting from one equilibrium to a new equilibrium.
We've done it for a demand shift to the right and a supply shift to the right. There are two shifts left though, aren't there? Demand shifting left, right? supply shifting left, I'm going to leave that to you guys.
What a nice exercise for you to do to see whether you really get it. It should be very simple because there are only two disequilibrium, aren't there? An excess demand or an excess supply. We've covered both here.
You just have to find that and go forward. Use this video. Use the previous video to make sure you can get that nailed on. But that is fascinating stuff.
You might say magical stuff for you guys seeing markets in action. Thank you so much for watching. Can't wait to see you all in the next video.